Interest-Only Mortgage or HELOC? Which is Better?

An interest-only mortgage offers the advantages of a home equity loan without regular monthly repayments of principal. As a result, you can tap into your home's value without tapping into your monthly budget to generate payments. But a home equity line of credit (HELOC) offers the same freedom from principal payments, while allowing you to withdraw equity as needed, offering the kind of convenience that you enjoy with a checking account, ATM card, or credit card. Which is better for you?

The powerful HELOC

Deciding which type of financing is going to work best requires a closer look at how these two types of loans function. One of the features that many borrowers find attractive about the HELOC is that it works on demand, like a checking account. If you don't need money, you don't have to borrow any or pay interest. When you do want to access your line of credit, you make a withdrawal, and fees for interest begin at that time. Using a HELOC is like using a credit card to take a cash advance, except that your real estate equity establishes the credit limit, and your rates are generally lower.

Advantages of interest-only loans

If you think your financial needs are greater now than they will be in the future, an interest-only loan may make more sense than a HELOC. Since rates are generally lower for interest-only mortgages, you can use the money now, while paying it back on a schedule that will be as inexpensive as possible. Let's suppose that you're in college now, and will be paying for your education for several more years. Let's further assume that you expect to have a steady income after graduation. In this scenario, the interest-only route would put more money in your pocket to pay bills now than a HELOC would, without placing unnecessary demands on your monthly budget.

HELOCs vs. interest-only loans: Compare and contrast

With an interest-only loan, you may have to refinance your current mortgage, which may mean additional closing fees. But HELOCs have significantly lower closing costs. If your credit rating is good, you may be able to find one with no closing fees at all. Remember that you're taking a second mortgage with a HELOC, and will be looking at two monthly payments instead of one. If you refinance to an interest-only loan, you'll still have only one monthly payment.

Both options have advantages. Compare the rates of interest and the terms very carefully. If you crunch the numbers, you can find the best solution to your cash crunch.